Know Your Budget 2019 Information to Insights · and its possible impact on oil prices have...

Know Your Budget 2019Information to Insights January 2020

©2020 Deloitte Touche Tohmatsu India LLP. 2

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Indicators

• Economic treading on thin ice

• Macroeconomic fundamentals stuttering

• Modi 2.0 began with big bang reforms

• Mega infrastructure spending announced

• Further rate cuts are on hold

• Extraordinary times call for extraordinary measures

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IndicatorsThe Union Budget 2020-21 has been presented amid an acuteeconomic slowdown, rising inflation, and high unemployment. TheIndian economy is going through a sustained slowdown as theeconomic activity has been losing momentum for over fivequarters now, with questions on whether the current economicheadwinds have bottomed out or are here to stay for longer.

Government expenditure growth has been doing the heavy liftingover the past few quarters as private demand has taken abreather with three of the four growth engines—privateconsumption, private investment, and exports—have slowed downsignificantly. Several factors—such as stagnating rural wages,tightening lending conditions (because of the ailing health of thefinancial institutions), and rising unemployment—are contributingto low demand for goods and services. Additionally, structuralfactors, such as changing consumer preferences among the risingnumber of millennials and technology innovations are transformingdemand patterns and contributing to the sluggishness.

On the industry side, several core sectors including auto, realestate, and manufacturing are in deep waters because of lowdemand resulting in a downward spiral of weakening corporateprofits, waning business sentiments, and declining investments.

Economic treading on thin ice

India continues to face global headwinds owing to policy uncertainties, falling growth and trade volumes, and technological changes across the world. Geopolitical tensions in the middle-east nations leading to oil price fluctuations are adding to economic woes.

Leading economic indicators point to gradual growth in the current quarter as well. With credit growth and rural income remaining weak, private consumption spending is unlikely to see a pick up soon. Besides, high food inflation is weighing on the pockets of consumers. On the investment side, excess capacity, falling order books, and highly leveraged corporate balance sheets will likely keep business confidence low and result in further postponement of investment decisions.

Weak demand driving slowdown

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Source: CEIC, RBI


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Source: CMIE, RBI. Note: NPA stands for gross non performing assets, IBC stands for insolvency and bankruptcy code, CAD stands for current account deficit, FDI stands for foreign direct investment and FPI stands for Foreign portfolio investments

The fiscal deficit crossed 114.8 percent of the annual budgettarget in the first eight months indicating further stress ongovernment finances. With government revenues likely to be lowbecause of the economic slowdown and reduced corporate taxrates, there are concerns over fiscal slippage this year unless thegovernment decides to curb expenditure. For an economy whosegrowth has primarily been supported by government expenditureover the past few quarters, a cut in spending may not be anoption for the government.

Consumer prices inflation surged to a more than five-year high inDecember, although core prices remained low. Food pricesskyrocketed, on the back of rising prices of vegetables, especiallyonion and tomatoes, pulses, and meat and fish.

The Rupee touched 72 rupees per dollar twice in January. Whilefactors such as slowing economic growth and a rising fiscal deficitweigh on sentiments, the recent unrest in the Middle-east nationsand its possible impact on oil prices have unnerved investorsabout India’s CAD and inflation outlook. Expect INR to remainvulnerable to short term flows and may remain around INR 72.5-73.5 per US$ this year.

Government security yield rates have come down markedly to 6.9percent from its peak (above 8 percent) in August 2018. However,the yield rates have seen an uptick from the past two months overconcerns regarding the economic slowdown. This may raisefinancing costs for private sector borrowers. Sectors with highcapital market borrowing, such as power and telecom may getaffected.

The current account deficit declined to 0.9 percent of GDP owing to acontraction in the merchandise trade deficit. However, CAD may comeunder pressure if oil prices increase as India is a net oil importer. It isestimated that every US$10 a barrel rise in crude oil prices expandsCAD by 0.4 percent of GDP. Besides, the share of exports in GDP hasremained dismal and decreased by over 6 percent since 2013.

The industrial production index in November suggest a rebound in theindustry sector with manufacturing registering an impressive growthrelative to the previous year. On the use-based front, consumerdurables and capital goods indices, which are often tracked to gaugemedium-term growth and the strength of consumer demand,improved on month-on-month basis. These two indices have beencontracting on a year-on-year basis since the beginning of 2019.

FDI inflows remained strong and received a US$26.9 billion foreigndirect investment in the first half of 2019. on the other hand, FPIflows were vulnerable. That said, their share in total investment hasdeclined by 6 percent since 2015. This bodes well for the economybecause direct investments are more stable and help in creating realassets on a long term basis. and the trend may continue as Indiaembarks on an ambitious infrastructure project to spur economicgrowth.

NPAs have declined for the first time in ten years and one of thereasons cited has been because of quick resolutions under the IBCAct. After rising to 11.2 percent of the gross advances, the ratio fell to9.1 percent in September 2019.

Macroeconomic fundamentals stuttering

Fiscal space, inflation, and currency valuation causing concerns.


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Financial restructuring

• The infusion of US$9.9 billion of

capital for bank capitalisation

• The merger of 10 public sector banks to form four larger banks

• The amendment of insolvency and bankruptcy code, enabling the

resolution of financial companies.

Corporate

tax rate rationalisation

• Corporate tax rate brought down to 22 percent from 30 percent,

subject to conditions

• New manufacturing companies (incorporated in FY 20) are to

pay lower tax rates at 15 percent

• Angel tax provision to be withdrawn for start-ups and their

investors

Measures to boost the export

sector

• Remission of duties for export products to offset export duties

for sectors receiving incentives up to 2 percent

• Expanded scope of Export

Credit Insurance Scheme by Export Credit Guarantee

Corporation

• Revised priority sector lending

norms for export credit

Measures to revive the

housing sector

• Relaxation of ECB guidelines for affordable housing for

home buyers, subject to guidelines

• US$ 1.41 billion last-mile

funding to complete ongoing housing projects, subject to

conditions

• Housing finance companies to

be allowed to borrow funds abroad at relaxed rules

Measures to boost the

automotive sector

• Increased depreciation cost for automobiles for corporates and

businesses

• Deferred one-time vehicle registration fee until June 2020

• BS4 vehicles purchased before April 2020 to remain operational

until the validity of the car's registration

• Increase liquidity and lending

• Improve balance sheets

• Reduce lending costs and NPAs

• Improve liquidity and solvency situations among ailing NBFCs, overall

financial health, and credit growth

• Reinvigorate private investments

and jobs through improved business confidence

• Improved profit margins will increase investors’ wealth,

leading to higher demand

• Enable companies to compete against peers in the global market

• Benefit MSME and small

exporters, increasing their contribution to exports

• Guarantee benefits to exports and improve competitiveness

• Boost demand for housing

• Release stuck capital from financial institutions

• Access capital from a larger

pool of funds

• Increase demand for vehicles

• Improve cash flow for manufacturers

Economic implications

Note: ECB refers to External Commercial Borrowing

Modi 2.0 began with big bang reforms

Key announcements to boost growth and their probable impact

Source: CMIE, RBI. Note: NPA stands for gross non performing assets, IBC stands for insolvency and bankruptcy code, CAD stands for current account deficit, FDI stands for foreign direct investment and FPI stands for Foreign portfolio investments


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IndicatorsTo further the efforts, the government accelerated its INR 102lakh crore infrastructure investment plan and set up a task forceheaded by Economic Affairs Secretary in December that wouldcreate a road map for the national infrastructure pipeline from2019-20 to 2024-25. With investment allocations announced forprojects in the infrastructure sectors (economic and socialinfrastructure), these projects are spread across 21 ministries and18 states and Union Territories.

This massive spending is expected to spur economic activity owingto this sector’s strong inter-linkages with the rest of the economy.In addition, such a massive investment will likely create jobs(including for the unskilled), boost rural income and purchasingpower, and provide equitable access to infrastructure for all,thereby improving economic efficiency and productivity.

Given the State and Centre equally share 78 percent of the burdenof the spending, this will reflect in a rising government fiscaldeficit in the coming years. One may argue that infrastructureassets are built for and consumed by several generations, andtherefore postponing the payment onto the future generation maynot be unreasonable. However, a significant fiscal slippage undercurrent circumstances may not bode well with investors and ratingagencies.

The other bigger challenge will be that of dealing with persistentstructural bottlenecks such as land acquisitions, labor challenges,environmental and other regulatory clearances, and complicated taxprocesses for a hurdle-free implementation of these massive projects.These roadblocks, which also impact the ease of doing any business inIndia, not only add to the project costs but also cause significantdelays triggering stress on the financial sector and ease of living.

Key announcements:

• ₹102 lakh crore National Infrastructure Projects (NIP) to help makeIndia a $5 trillion economy by 2025.

• Power, railways, urban irrigation, mobility, education, health formbulk of infra project pipeline.

• Out of the projects included in the national infrastructure pipeline,43 percent are under implementation, 33 percent are at aconceptual stage and 19 percent are under development.

• Private sector to share a 22-25 percent of NIP investments, Centreand states the rest.

• 18 states have so far come up on board.

• National Infrastructure Pipeline Coordination mechanism will belaunched to monitor identified infra projects.

• Another ₹3 trillion worth of projects will be added to the project,taking the total to $105 trillion.

Mega infrastructure spending announced

Government spending can be a trigger for boosting growth


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Policy rates

Repo rate (LHS) Reverse repo rate (RHS)

The government’s measures have been complemented withprudent monetary policies by the central bank. The RBI cut ratesfor five consecutive times by 135 basis points in 2019 bringing therates to their lowest since 2010. In addition, the RBI hasmaintained its accommodative monetary policy stance andsignaled that the stance would remain unchanged “as long as it isnecessary to revive growth.”

The RBI has taken steps to improve cash flow to shadow lenders,including allowing banks to lend more, providing partial creditguarantees, and easing banks’ mandatory liquidity ratios. Besides,it is closely monitoring the top non-bank financial corporations(NBFCs), who contribute about 20 percent of the total credit, tocontain stress on key NBFCs and improve credit growth in theeconomy.

However, the MPC kept the key policy rate unchanged at 5.1percent with an accommodative stance in its December meetingciting concerns over rising prices. This suggests that the currentdecision was taken keeping in mind the need to ensure economicstability even as investment and credit growth have declined.

However, the fall in repo rates has not translated into cuts inlending rates despite the sharp fall in deposit rates charged byscheduled commercial banks relative to the lending rates. Banks’margins remain stressed, which together with high NPAs has ledto reluctance among banks in reducing lending rates further.

With credit growth failing to pick up, there is demand from theindustry to keep the monetary policy accommodative. However, anyfurther rate cuts will be contingent on the rise in prices and inflationexpectations. With inflation breaching the flexible target of 2-6percent in the latest month and a significant risks looming on oil pricerise, any further rate cuts may not be in the cards any time soon.

Apart from the near-term growth-inflation dynamics, a lot will alsodepend on the measures that the government might undertake toboost the economy in the upcoming budget and how these measureswill translate into the fiscal situation in the economy. While themarket now expecting a much delayed easing, the growth-inflationdynamics will keep the MPC on its toes.

Further rate cuts are on hold

Door to a further rate cut fast closing because of high inflation

Source: CMIE, RBI. Note: MPC stands for monetary policy committee


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IndicatorsImmediate measures to boost growth

Incur expansionary fiscal policy by raising capital expenditurethat leads to asset creation (and reducing revenue expenditure).The government has already set the ball rolling with theannouncements on infrastructure spending. The government hasto spend to build momentum and ensure that economic activitygrows at a sustainable pace. In the process, the government canexceed the deficit target because extreme circumstances call forextreme measures. Germany, a strong proponent of a balancebudget, incurred a strong fiscal deficit during 2008-09 to help theeconomy come out of the crisis. The US fiscal deficit shot up to 8.1percent during GFC.

Take measures to control of the stagflationary1 situation bycontrolling prices on an immediate basis. Given that globally, foodprices are seeing a rise, controlling food prices may not be easy.Supply chain has to be improved with better coordination insupplying vegetables between farmers and final consumers andbetter management of inventories.

Quick and bolder reforms in the upcoming budget to build onthe momentum of earlier announced reforms will have animmediate impact in uplifting investor and market sentiments.This will reflect in their investment decisions. The governmentshould continue these efforts even after the budget. The spur ofgovernment announcements over the past few months suggestthat policymakers are willing to tackle the problems head-on.

Credit support to farmers and transfer income in the hands of ruralconsumers will help spur rural demand. This should be followed byincentives to labour-intensive industries such as construction,housing, road-building and irrigation, which can create jobs andincome and therefore, trigger immediate consumption.

Improving credit flow to both consumer and industry will becrucial as the void created because of reduced lending by NBFCs isimpacting demand. Lending to industries has suffered tremendouslybecause of their high leverage and bad debt issues. With IBC resolvingissues of bankruptcy and defaults, one-time roll over of debt on a caseby case basis could be a solution.

Rationalise GST rates and improve tax collection mechanismwill help in improving revenue collection in the economy and make iteasier for companies to file returns.

Desperate times call for desperate measures

What to expect in the upcoming budget

Note: High inflation, high unemployment and low growth scenario


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IndicatorsLong-term measures

Develop a globally competitive agriculture, industry andservices that is modern, sustainable, and inclusive. This willrequire focussed effort toward investing in agricultureinfrastructure, improve last mile connectivity and upskillingworkers.

Strengthen the institutional structure that enables inachieving the first. Promotion of enablers such as physical anddigital infrastructure, factor market reforms (land, capital, andlabour ), education and up-skilling, investment in innovation andR&D and improving governance will not help in reducing the costand improving the ease of doing business in India but also unleashIndia's economic potential in future.

To build on previous reforms, such as Digital India, SmartCities and channelizing resources to ensure a fast completion ofthe projects with greater transparency. In a vast country likeIndia, national transformative projects take time to implement,but it will is important to remove obstacles that delay projects.

Opening up to more FDI will likely help channelize the capitalinflows into more efficient manner. Increasing FDI in insuranceand insurance will likely help overcome capital constraints thatthese sectors face and lead to better management. Railways,which lacks capital for better functioning, should be opened up forFDI for its operations.

India’s readiness for technology innovations will determine thefuture of work and opportunities to address structural changes. AI andautomation are fast changing the technology landscape. Cloud and Bigdata analysis can help businesses to understand changing consumerdemand and preferences better and strategise accordingly.

Promotion of the start-up ecosystem that can help in innovationand employment generation. A stable regulatory policy can provideconfidence among investors who are eyeing Indian startups for betterreturns. As AI, IoT and Blockchain become the backbone of futuretechnologies; the government must set-up a deep tech fund toencourage start-ups within these areas.

Aligning with WB’s Global sustainable goals to tackle climatechange and resource sustainability and create an inclusive and diversework environment to improve the standard of living.

Integrating into worlds GVC through prudent trade policies and byovercoming trade infrastructure bottlenecks. A majority of theindustry sectors are not yet a part of the global supply chain or GVC.They are highly protected through tariff and duty structures makingthem less competitive globally.

What to expect in the upcoming budget

Desperate times call for desperate measures


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IndicatorsBudget Proposals to Boost Growth

• Uniform tax rate without exemption,• New slabs for those in higher-income groups,• pruning personal income tax rates (in accordance with those in corporate tax).• 100 percent FDI for insurance intermediaries while local sourcing norms to be eased for FDI in single-brand retail• Merging of NRI portfolio scheme route with foreign portfolio investment route• Investment of INR 5 trillion for railways infrastructure till 2030

Budget Proposals on Agriculture, Rural, and Social Sectors

• Government to replicate zero-budget farming under which ease of doing business and ease of living should apply to farmers this concept will help double farm incomes by 2022. In addition government shall support private entrepreneurs in agriculture and focus more on agricultural infrastructure

• 19.5 million h to be constructed under PMAY from FY20-22

• 1,25,000 km of roads to be upgraded under PM Gram Sadak Yojana

• Drinking water to all rural households to be provided by 2024

• Government to explore additional funds for Jal Shakti by accessing the Compensatory Afforestation Fund management and Planning Authority fund.

Budget proposals (post budget)

Economic Outlook: Way Forward


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IndicatorsBudget Proposals on job creation

• Government to replicate zero-budget farming under which ease of doing business and ease of living should apply to farmers this concept will help double farm incomes by 2022. In addition government shall support private entrepreneurs in agriculture and focus more on agricultural infrastructure

• 19.5 million h to be constructed under PMAY from FY20-22

• 1,25,000 km of roads to be upgraded under PM Gram Sadak Yojana

• Drinking water to all rural households to be provided by 2024

• Government to explore additional funds for Jal Shakti by accessing the Compensatory Afforestation Fund management and Planning Authority fund.

Budget Proposals on Banking and Financial Sector

• NPAs of commercial banks declined by INR 1 trillion while number of public sector banks have been reduced by 8, through consolidation. In addition INR 700 billion recapitalization proposed for public sector banks

• Government to also provide one-time 6-months partial credit guarantee for public sector banks, on the purchase of pooled assetsof financially sound NBFCs.

• Pension Fund Regulatory Authority to be separated from the National Pension Scheme Trust

• In order to improve capital inflows, government shall readjust its holdings in CPFCs. Further strategic disinvestment of select CPFCs will continue to remain a priority

• Air India disinvestment to be reinitiated, with an enhanced target of INR 1.05 trillion from disinvestment

Budget proposals (post budget)

Economic Outlook: Way Forward

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